Modern Monetary Theory

Introduction

In the space of little more than a decade, Modern Monetary Theory has spread from a relatively small group of academics to become a mass movement for economic change.

In general terms, MMT is a macroeconomic paradigm based on an understanding of monetary and fiscal dynamics that stands in stark contrast to neoclassical, neo-Keynesian, and other mainstream approaches. It is most well known for the claim that since monetarily sovereign governments issue their own currency and determine the unit of account, there are no purely financial constraints on public spending. However, at its core is the recognition that money is a creature of public law and state authority, not private exchange, and thus monetary systems can and should be designed in ways that best further public purpose.

Most modern economies use a ‘fiat’ currency, which gains acceptance because it can be used to meet legal obligations imposed by the state, and needn’t be convertible to a physical commodity (such as gold). Such countries face no technical limit to the amount of money that can be created. Therefore, there are no monetary constraints on a nation’s prosperity – there are only the physical limits of the economy’s productive capacity, and administrative, social, or political constraints on utilising that capacity.

While MMT has roots in historical and theoretical discussions over the nature of money, and its contemporary scholarship features relatively technical analysis of the monetary operations of governments and central banks, it has also acquired a broad appeal among progressive campaigners. No one group claims sole ownership over the theory, but prominent groups include the Modern Money Network and Sunrise Movement in the United States, Red MMT in Spain, Rete MMT in Italy, and the Gower Institute for Modern Money Studies (GIMMS) in Britain.

In the United States in particular, politicians and campaigners have drawn on MMT principles to promote dramatically increased public spending on social and environmental priorities, such as a ‘Green New Deal’. Their arguments have begun to affect the national conversation over economic policy.

MMT in 10

L. Randall Wray, an early member of the group of academics who refined and popularised MMT, explains the paradigm in 10 points, intended to capture the logic of the MMT position in a comprehensive way. The details of some of these points are unpacked further down this page. Paraphrased, they include:

Money is an IOU, because the issuer promises to accept it back in payment of debts they are owed. That IOU is denominated in a ‘socially sanctioned money of account’, usually established by a centralised authority: the state.

Taxes (or other obligations) drive the currency. Sovereign states can impose obligations that give the currency value, since it can be used as payment.

Anyone can issue money; the problem is to get it accepted. People who try to issue an IOU in the unit of account without support from the sovereign will struggle to make their promise credible.

‘Redemption’ of money refers either to accepting it as payment of taxes, or converting to gold, foreign currency, etc. on request. However, the latter is no longer promised by the central bank in countries with non-convertible, floating exchange rate currency regimes.

There is no chance of an involuntary default on sovereign debt, ‘so long as the state only promises to accept its currency in payment’ – in other words, so long as the debt is denominated in a floating, non-convertible currency issued by the sovereign itself.

Functional Finance: the public finances should be managed in a ‘functional’ manner, i.e. with an eye to the actual effects of decisions in particular contexts, in order to achieve full employment with price stability. This doctrine stands in contrast to ‘sound finance’, which evaluates budget decisions against predetermined beliefs about the desirability of deficits and/or surpluses.

The Job Guarantee, a policy whereby the public sector will employ anyone willing and able to work at a fixed wage, is a critical component of MMT as a macroeconomic framework. It is thought to anchor the currency and provide greater price and financial stability than the alternative (i.e., than maintaining a pool of reserve (unemployed) labour).

Hyman Minsky’s lessons on financial instability: that periods of stability and growth see continual changes and increased risk-taking in financial markets, which lead to a build-up of instability such that ‘a slight reversal of prosperity can trigger a crisis.’

The government’s debt is a non-government asset, following from a view of sectoral balances across the macroeconomy. The non-government sector (including households, firms, and the rest of the world) must, as a simple fact of accounting, hold assets that correspond to the liabilities of the government sector.

The central bank is neither independent nor potent – conventional monetary policy, which operates primarily by manipulating the overnight interest rate on lending between banks, is weak and its impact is at best uncertain. In addition, monetary policy implementation always and everywhere requires the coordination and support of the treasury. This final point often leads to a preference for managing macroeconomic conditions through coordination between fiscal and monetary authorities, typically in the form of ‘permanent zero interest rate policy (ZIRP).

Wray’s 10 points reveal that MMT, like other schools of economics, is a theoretical paradigm where certain dynamics in the economy follow logically from fundamental premises, and from which policy insights can easily be drawn.

Thought Genesis and History

Chartalism

MMT was initially known in academic literature as ‘Neo-Chartalism’. Chartalism is a theory that stresses the importance of social context for the existence of money. It is typically contrasted with the ‘orthodox’ (‘M-form’, ‘Metalist’, or ‘commodity money’) view, which holds that money was invented to facilitate exchange, and that its value was initially determined by the value of a physical commodity (e.g. gold or silver) from which it was made. By contrast, Chartalism holds that ‘the value of money is based on the power of the issuing authority, and not by any embodied or backing precious metal’ (Wray, 2000).

Several important intellectual precursors to MMT held this view. George Knapp argued in 1924 that ‘the attempt to deduce [money] without the idea of a State [is] absurd’. This was an explicit contradiction of commodity money – Knapp claimed that ‘the soul of the currency is not in the material of the pieces, but in the legal ordinances that regulate their use.’ Several years later, Abba Lerner also contributed to this standpoint with an article entitled ‘Money as a Creature of the State’.

Neo-chartalism reorients the emphasis of monetary theory on the currency systems prevalent in the world today, which, almost without exception, are fiat currencies issued by sovereign governments. The phrase ‘taxes drive money’ captures this recognition that the state creates the value for a common currency by leveraging its centralised authority. It does so by imposing non-reciprocal obligations (e.g. taxes and fines) that can only be paid by tendering the currency.

Functional Finance

Building on the lessons of neo-chartalism, MMT next draws important conclusions about the nature of public finance and government spending.

MMT scholarship has since applied the chartalist understanding of money and taxation through analysis of the economy’s sectoral balances, an approach pioneered by Wynne Godley. As Stephanie Kelton argues, ‘proceeds from taxation and bond sales are not even capable of financing government spending since their collection implies their destruction.’ When the fiscal authority (Treasury) receives tax payments, the banking system loses the same quantity of money in reserves. Similarly, the purpose of bond sales is argued to be the same: draining reserves, and thereby relieving pressure on the policy interest rate, due to the incentives faced by banks holding excess reserves. The central bank provides the reserves necessary to ensure bond sales clear.

This accounting logic gives a concrete, practical face to the occasionally abstract theory of money that MMT is ultimately based on. It also has radical consequences for how to understand the options for fiscal policy faced by a monetarily sovereign government.

In 1943, Lerner wrote another article, ‘Functional Finance and the Federal Debt’. There, he staked out the position that:

‘government fiscal policy, its spending and taxing, its borrowing and payment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound.’

Put differently, this means that there should be no concern over the size of the government deficit on the grounds of ‘debt sustainability’ (or other axioms about the desirability of running a budget in balance or in surplus). Insolvency of a monetarily sovereign government is impossible.

Nevertheless, government spending adds to a real economy where productive resources are used and prices are set; public spending must take these ‘productivity enhancing’ factors into account. This is the ‘functional’ in Functional Finance – fiscal policy should be operated with a view only to the function it serves in achieving real economic effects. MMT scholar Bill Mitchell expresses the principle as:

‘the desirable deficit outcome at any point in time to be a function of the state of non-government spending and the utilisation of the productive capacity of the economy.’

Financial Instability

Alongside Knapp and Lerner, MMT is indebted to Minsky, who proposed that ‘money manager capitalism’ – the form of economic order that became ascendant in the post-war world – is inherently unstable.

In short, the implication of Minsky’s view was that a period of stable and growing prosperity leads caution among private firms to lapse. Firms, households and banks undertake ‘innovations’, engage in speculative activity, and start to take on more risk, increasing fragility in the economy. As the cycle continues, short-term debt is increasingly used to cover interest charges on earlier investment. This behaviour makes a crisis almost inevitable over a long enough stretch of time (Minsky, 1982).

The privileged position Minsky occupies in the lineage of MMT has affected contemporary thinkers. Many hold that the public financial architecture must recognize that there there are multiple sources of new purchasing power and investment beyond government spending. The resultant purchasing power has consequences for economic activity, the distribution of wealth and income, and financial stability, and so must be addressed by any comprehensive paradigm. Public authorities must be on guard against the effects of private money markets, even while the government operates Functional Finance (for an example, see Warren Mosler’s ‘Proposals for the Treasury, the Federal Reserve, the FDIC, and the Banking System’).

Policy recommendations

It is important to recall that MMT is not prescriptive of specific spending priorities. It simply undermines any objection to increased public spending that is based on an idea of monetary scarcity, or that the nation ‘can’t afford it’. Instead, as according to Functional Finance, spending proposals should be assessed on the basis of their effects on society and the economy.

Nevertheless, the intellectual framework for understanding the modern economy that MMT provides offers several priorities and directions for building government institutions. Éric Tymoigne and L. Randall Wray have written that:

‘Financial stability, price stability and full employment… are important goals that have to be met independently from one another by putting in place structural policies that work independently of the current political climate, and that manage as directly as possible the goal that needs to be achieved.

MMT rejects the traditional trade-off between inflation and unemployment, and does not rely on economic growth and fine-tuning to reach full employment.’

An important plank in the MMT framework that helps to achieve these goals is the Job Guarantee. The JG is a ‘buffer-stock’ scheme for the job market where the state functions as ‘employer of last resort’. Anybody who wants a job on the public scheme can have one at a fixed wage; the scheme, therefore, absorbs workers displaced from private sector employment. Mitchell (2000) claims that the JG wage ‘prevents serious deflation from occurring and defines the private sector wage structure’ (in the sense of providing a viable outside option for those on low wages).

MMT reverses the typical role played by a nation’s economic institutions, in that typical MMT policy platforms see fiscal policy, and not the manipulation of interest rates by the central banks, as the proper tool for controlling inflation. For MMT advocates, this is a simple consequence of the fact that taxes destroy money, and also follows from Wray’s 10th point: that a policy interest rate is a weak tool for manipulating spending in the real economy.

For the part of the JG, Mitchell proposes a ‘Buffer Employment Ratio’ or incomes policy to keep the lid on inflation resulting from the increased government spending such a scheme would require. (Importantly, MMT advocates acknowledge that there are other sources of inflation beyond excessive demand, and other tools that can address inflation in general, ranging from better financial regulation (Minsky) to reducing accounting control fraud (Bill Black) to improving market governance and competition law (Fred Lee)).

Critiques & Responses

Despite its growing popularity, MMT has not enjoyed an easy reception from the mainstream of economic thought and commentary. Eric Témoigne and Wray classify critiques of the paradigm into five categories: ‘views about origins of money and the role of taxes in the acceptance of government currency, views about fiscal policy, views about monetary policy, the relevance of MMT conclusions for developing economies, and the validity of the policy recommendations of MMT’ (2013).

Some have questioned whether MMT really offers any novel lessons for macroeconomic policy that aren’t already implicit as components of a more conventional view, mainstream view. For instance, Simon Wren-Lewis has argued that:

1. ‘MMT seems obsessed with the accounting detail of government transactions;
2. This seemed to lead to ideas that I thought were standard bits of macroeconomics.’

Similarly, an article published in mid-2018 at the Institute for New Economic Thinking (INET) by Arjun Jayadev and J. W. Mason claimed that ‘the analysis underlying [MMT’s policy proposals] is entirely orthodox.’ They elaborate:

‘The difference between MMT and orthodox policy can be thought of as a different assignment of the two instruments of fiscal position and interest rate to the two targets of price stability and debt stability. As such, the debate between them hinges not on any fundamental difference of analysis, but rather on different practical judgements—in particular what kinds of errors are most likely from policymakers.’

Jayadev and Mason accordingly target the switch in policy emphasis from interest rate-fixing at the central bank to fiscal policy as the main tool of macroeconomic stabilisation, a point that Wren-Lewis also sees as the main divide between MMT and more ‘mainstream’ economic thinking.

However, the INET authors’ argument addresses ‘the logic of the functional finance position rather than MMT as a body of thought’, and they admit to ‘make only limited references to MMT literature’.

This has led MMT scholars to respond that the economic paradigm they have developed goes far beyond the implication of functional finance, and rests on fundamentally different premises about the economy from mainstream views (such as Kelton’s argument about the impossibility of bond finance or taxation to fund government spending). The INET critique also gives no room to the ideas on investment and financial dynamics adopted from Minsky, which lead to differences between MMT and the mainstream in terms of understanding the business cycle.

Finally, MMT advocates take issue with the assumptions about human behaviour and macroeconomic dynamics used to structure the very formal model used by Jayadev and Mason in their analysis (see Mitchell for more detail). For example, MMT denies that there is a ‘natural’ rate of interest at which the economy will reach full employment, if only it is set by the central bank (which can be prevented by the zero lower-bound). In that sense, MMT advocates do not see their theory as a ‘preference’ for fiscal policy over monetary policy as a tool of macroeconomic stabilisation. Instead, from an MMT perspective one of those tools (monetary policy) can never achieve what it claims it can achieve, whereas the other can.

Economic theory as a ‘lens’

One category of objections to the MMT narrative concerns how it relates to the institutions and practices established to manage government spending and monetary policy in reality. Some critics have claimed that MMT has few lessons for modern economies. They argue that legal structures – such as central bank independence and laws prohibiting monetary financing of deficit spending – mean that MMT is only true in a stylised world, and therefore lacks relevance to the real one.

‘MMT identifies two levels of reality. The first level defines the intrinsic characteristics of the the monopoly fiat currency issuer which clearly lead us to understand that such a government can never run out of the currency it issues and has to first spend that currency into existence before it can ever raise taxes or sell bonds to the users of the currency – the non-government sector…

The second level of reality [is] the voluntary institutional framework that governments have put in place to regulate their own behaviour. These accounting frameworks and fiscal rules are designed to give the (false) impression that the government is financially constrained like a household – that is, in context, has to either raise taxes to spend or issue debt to spend more than it raises in taxes.’

Elsewhere, he describes MMT as a lens ‘which allows us to see the true (intrinsic) workings of the fiat monetary system.’

The power of MMT, then, lies in its ability to reveal the gap between what is necessarily true about monetary systems, and other, contingent facts that are only true under present circumstances. It shows that gap for what it is: a political construct that persists only because our society so chooses. Structures like central bank independence must be argued for on their merits, and cannot be referred to as ‘how the world really works’. Ultimately, MMT has become a much broader project than a single economic theory, and is consistent with insights from historical, anthropological, legal, and sociological approaches to understanding money, the economy, and society. Increasingly, the future of MMT is interdisciplinary.

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